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What to Expect When Spirit Airlines Reports Earnings

Two costly hurricanes and an ongoing price war have investors bracing for an ugly third quarter.

Spirit Airlines(NYSE:SAVE) will release its third-quarter results on Oct. 26. While the company made a long-awaited return to unit revenue growth last quarter, Spirit's overall revenue picture for the rest of the year looks overwhelmingly negative thanks to a couple of hurricanes and the effects of a fare war that are still spreading throughout Spirit's network.

It's already been a heck of a year

Even before hurricane season got underway, Spirit's year was off to a rough start. The company had to cancel more than 850 flights back in May due to a dispute with its pilots, costing Spirit roughly $45 million in Q2.

Image source: Spirit Airlines.

Thanks to a fare war with United Continental that was just getting started as Q2 results were reported, Spirit's initial Q3 outlook included a unit revenue decline of 2%-4%. That guidance was slashed after Hurricane Harvey hit Houston, one of Spirit's larger markets. CFO Ted Christie revealed at a recent investor conference that, compounding the airline's problems, Spirit has seen deep discounting spread quickly, from markets that represent 25% of its revenue at the end of Q2 to markets that now represent around 50% of its revenue.

And that was all before Hurricane Irma.

The ultimate impact on Q3

While neither Fort Lauderdale nor Orlando -- Spirit's largest and third-largest markets, respectively -- were in Hurricane Irma's direct path, both airports were closed for multiple days due to the storm. And with Florida and the Caribbean accounting for a whopping 45% of Spirit's network, the financial impact on Spirit's Q3 results will be severe.

In all, Spirit said it was forced to cancel over 1,650 flights during the third quarter due to hurricanes. Along with what it called "the overhang from the pilot work action earlier in the year," the company says the storms will cost it around $40 million in Q3 revenue, and around 450 basis points in operating margin. Interestingly, the company subsequently raised its Q3 unit revenue guidance slightly, and now expects a 6.5% year-over-year decline, with the improvement due to better yields (the average fare paid per passenger, per mile) and load factors.

For the third quarter, analysts, on average, are now expecting Spirit to report revenue of $686 million, which would be 10.4% growth over last year. They're also expecting earnings per share of $0.83, which would be a decrease of around 33% from last year's EPS of $1.24. Just 90 days ago, before both hurricanes -- and before Spirit's fare war problems intensified -- analysts were expecting EPS of $1.56.

Will the competitive environment force a strategic shift?

Regardless of what third-quarter numbers look like, the longer-term threat to Spirit's growth is a prolonged low-fare environment. Deutsche Bank recently downgraded Spirit from buy to hold, while lowering its price target to $38, citing the intensity of competition and the rollout of basic economy-type fares by the larger legacy airlines.

Spirit has recently said that it's considering a different growth strategy if deep discounting by the major airlines becomes the new normal. Rather than trying to lift yields, Spirit says it may choose to embrace lower fares and pursue higher volumes and load factors instead, which plays to the airline's low-cost-structure advantage and its high ancillary revenue model for non-fare items like advance seat selection and baggage.

I expect management to have a lot more to say about the fare environment -- and how Spirit plans to respond -- on the conference call.

What about Spirit's efforts to improve reliability?

In early 2016, newly appointed CEO Bob Fornaro made it a top priority to improve Spirit's reliability and customer perception. And while the company had made measurable progress on this initiative, the airline's 2,500-plus canceled flights this year will no doubt be a big setback, likely dinging the company's on-time performance and its complaint ratio (its number of complaints per 100,000 passengers).

Fornaro had previously talked about these initiatives as an 18-month effort. Given that that time frame is now coming to an end, I'll be curious to see how (or whether) Spirit plans to get these metrics moving back in the right direction after this year's series of unfortunate events.